Tax reform topped concerns, but treasurers have plenty of other issues to consider.
The Treasurers’ Group of Thirty Large-Cap Edition peer group heard presentations by Deutsche Bank strategy experts about the latest developments in tax reform and other treasury-pertinent issues. The bank’s co-head of global debt explained how frequent issuers can most effectively approach the market, while members exchanged tips. They also discussed capital allocation, where to invest cash, and other topics. Here are three key takeaways:
1) The Bank Wallet. How much business do you have to support your credit group, and how can you right-size? Be assertive about what you include in the wallet when you talk to your banks.
2) Pressure Will Build. Be careful what you wish for on tax reform. Activist investors will want cash distributed to shareholders, impacting corporate capital structure and ratings. Get senior level approval on a playbook to address a range of potential scenarios.
3) Best Practices for Frequent Bond Issuers. T30LC members must balance the demands of investors and bookrunners seeking bigger deals with corporate needs in terms of size and tenor.
Tax Reform: Preparations for Possible Repatriation Opportunities
Regardless of the outcome for tax reform (comprehensive or something less ambitious), a repatriation holiday appears likely. Unlike the Homeland Investment Act, a part of the American Jobs Creation Act of 2004, the new version most likely will be mandatory. The Ryan-Brady plan calls for a one-time tax of 8.75% for cash and 3.5% for noncash assets, payable over eight years. The market implications for comprehensive tax reform are potentially significant. Roger Heine, Deutsche Bank’s Head of Americas Liability Strategies, Debt Capital Markets, led the discussion.
KEY TAKEAWAYS
1) Members are prepping. A majority of survey-responding members have prepared various scenarios for senior management regarding repatriation and/or tax reform. They have also quantified after-tax proceeds with the tax group, and/or mapped out the potential use of proceeds. Only 7% have changed their forecasting process or prepared scenarios for the rating agencies. Potential opportunities they see for freed-up cash flow include:
- Changes to the composition of their debt portfolio in the near term, putting more debt offshore and less onshore, with no impact to overall leverage.
- Long-term offshore cash investment, short-term debt issuances.
- More opportunities to borrow outside the US when favorable conditions arise, and better liquidity options to handle seasonal or unexpected cash needs.
2) Activists to climb the barricades. Roger Heine said the bank’s research suggests there will be tremendous pressure to bring home the cash and distribute it to shareholders. Deutsche Bank estimates upward of $1 trillion in cash could be repatriated. Approximately $200 billion will pay down existing loans collateralized by the stranded cash, leaving $800 billion or a bit less to be allocated to shareholders, M&A or capex. The latter is “theoretical,” since capex has not been a significant allocation for already cash-rich companies.
3) Does eliminating interest deduction mean corporates will hold less debt? Some Wall Street soothsayers think so, but Deutsche Bank says debt is here to stay. Between 2000 and 2016, there’s been no change in the corporate tax rate, and yet leverage has risen as corporates have issued more debt, and credit ratings have drifted down to what’s now viewed as the more optimal BBB range. There’s nothing tax-motivated about that trend, Roger said. “If the tax shield [from interest-rate deductions] was so important, you wouldn’t see this.”
Where to Invest Cash Now?
Just as treasurers adjust to money market fund reform, they may soon face huge cash repatriation inflows. Along with a potentially more upwardly sloping yield curve stemming from the Trump administration’s America-First economic focus, risk correlations and asset allocations may have to change dramatically. Are corporates shifting out of government funds and back into prime? How should treasurers think about duration, and what products are emerging in the prime space?
Just a third of T30LC respondents have adjusted their cash portfolios to prepare for rising rates, and 87% have not restructured or managed their investment portfolios differently to prepare for repatriation, instead waiting to see what tax package actually comes to pass in the end.
After MMF reform kicked in in late 2016, casting prime funds out of favor, members of the T30LC reported in the survey that their favored choices instead—other than government-only funds—include:
- Some fund companies are offering offshore prime funds that typically provide more attractive returns than onshore funds for the same duration because different regulations apply.
- One T30LC member’s company has shifted money to its captive to capture higher rates of return without the accounting issues, “and then we repo those investments and put the cash back in to use as a liquidity backstop.” The strategy requires putting an intercompany loan in place and is relatively easy to implement.
In addition to the large cash concentrations in low-yielding markets that is a shared problem for many MNCs, they also have to grapple with several emerging market countries that are making it increasingly difficult to repatriate cash, such as Egypt and long-time problem child Venezuela, with Nigeria also joining the FX controls fold. “Sooner or later the problem will go away,” one noted drily. “Just not the way you want it to.” All the more important, therefore, to cautiously manage the cash held in safer jurisdictions. New investment products to increase yield may be introduced in response to changing regulations and may be tempting, but for most, only appropriate for a small allocation of the overall portfolio (or the career risk rises).
OUTLOOK
There are still plenty of reasons to issue debt even without deductions. It’s still less expensive for issuers than equity, Roger said, and preferred stock would no longer be disadvantaged tax-wise relative to debt. Pension funds and infrastructure projects will still need longer-term funding.
Debt Capital Strategies for Frequent Bond Issuers
T30LC members are often frequent bond issuers—going to market twice a year puts issuers in the upper 20th percentile in terms of frequency, Deutsche Bank says. Marc Fratepietro, Deutsche Bank’s co-head of global debt capital markets, provided a list of important considerations, and members of the group chimed in with their own insights.
KEY TAKEAWAYS
1) Balance the demands. Issuers must “listen” to the market and be responsive, but not overly so. Investors want the biggest deals and tranches possible, to bolster liquidity, as well as issuance predictability.
- But don’t be too predictable. Cadence is a major challenge, and one key element is predictability. Corporates that issue debt suddenly and without warning will pay a premium and see volatility in their spreads, but overly regular issuers will likely prompt investors to lighten up on the paper before the deal, to push spreads wider.
- Size is also key. The investor ideal is a single, massive transaction a year offering large, liquid tranches, but that may not jibe with the needs of the issuer, which must consequently search out the minimum deal size that’s relevant to investors. “Coming up with the optimal size for your borrowing program is a big best practice for borrowers,” Marc said, noting that elements such as a par call feature—promoted heavily by BlackRock—can play a role.
2) Tenors shorten as concerns mount. “Companies are clearly moving to the shorter end of the curve and focusing on shorter tenors, and the average maturity is down this year,” Marc said. Partly that’s due to increased issuance by financial companies, and corporates shortening their tenors may be waiting to see what happens in terms of tax reform, Marc said, but other borrowers have intentionally issued more long bonds because they anticipate longer-term debt to be grandfathered. Marc noted that investors have different portfolio metrics, so issuing securities across different points of the curve will enable companies to tap into more “pockets” of investor money.
3) Investor marketing ramps up. Frequent issuers, even those doing just two predictable deals annually, are engaging more in non-deal marketing to update investors on their stories, often on an ad hoc basis, Marc said.
OUTLOOK
Unfolding US tax reform will continue to weigh on corporate issuance strategies. Improving economies in Europe and elsewhere are prompting more floaters. A mix of tenors is prudent risk management.
Capital Allocation Strategy
Is there an optimal way of allocating capital toward growth projects, acquisitions, dividends and buybacks? What role should share repurchases appropriately play in treasurers’ tool kits toward total return to shareholders? Joining two bankers from Deutsche Bank, two members described their companies’ approaches to allocating capital.
KEY TAKEAWAYS
1) Too much cash can reduce valuation. Many factors impact valuation, but a Deutsche Bank analysis of enterprise value-to-earnings vs. cash and investments-to-market-cap-ratios suggests the former gradually decreases as cash grows. Returning more cash to shareholders might improve cash-adjusted multiples, perhaps due to reduced bundling costs and less risk that the company may “waste its cash pile.”
2) Dividends are sacrosanct. Higher-dividend stocks simply do not outperform lower-dividend stocks, creating a quandary for corporates and prompting some to avoid dividends altogether. Nevertheless, he added, there are some benefits:
- Steadily increasing dividends appear to be favored by investors.
- Companies with increasing dividends tend to have significantly higher average risk-adjusted returns statistically compared to those with stable dividends.
- One member said his company has only cut its dividend once, when teetering on bankruptcy, and the dividend has returned to a record high. “The dividend is like a line in the sand, and as an investor I like that because it makes the company a much better steward of capital.” Do everything else first before cutting the dividend.
3) The buy-high dilemma. Companies are routinely criticized for buying back shares at record high prices. Deutsche Bank research suggests that large-cap, low-beta companies benefit from buying back stock continuously and not waiting for dips, while companies whose stock prices and betas are volatile—often smaller firms with less visibility—benefit from a wait-and-see strategy to buy when the price dips.
Bank Relationships and the Wallet
In the bank wallet, everything counts! Members debated managing bank relationships and sharing the wallet. How much business do you have to support your credit group, and how can you right-size? Also, be assertive about what you include in the wallet when you talk to your banks. Many of them try to wiggle out of accepting that pension management fees, for example, should be included; push back to make sure everything you count gets recognized by the banks. Not to mention that in the new world order of Basel-mandated ratios, operational cash balances are more valuable than ever (up to a point…).
Wallet analysis and the subsequent corporate-to-bank relationship discussions are conducted most frequently on an annual basis. But there is a case to be made for a longer—perhaps even up to three years—horizon for analysis. While many aspects of the bank revenue, such as cash management, transaction fees and other recurring services, can be fairly assessed annually, other revenue streams may be much more ad hoc but moresignificant when they do occur.
OUTLOOK
There are no firm capital-allocation rules, and strategies vary significantly depending on the company. For large-cap companies, though, whether for share repurchases or dividends, a steady approach with few, but well-explained changes appears to be the best strategy. The focus of investor communications should be on business growth, margins, etc., with a well-thought-out capital return strategy humming along nicely in the background.